Intel Inside the War Room

Can low prices and new businesses help it weather the slump?

When Applied Micro Circuits (AMCC ) Chief Executive David M. Rickey strode onto the stage at a communications chip conference in late March, the crowd was waiting for a clue about just how bad things had gotten in the $210 billion semiconductor industry. Rickey didn't keep them waiting. "We are sucking wind," he said bluntly. "Any questions?"

Intel Corp. (INTC ), for one, doesn't seem to have any. In response to a downturn that on Apr. 17 left its first-quarter operating profits 75% lower than a year ago, the industry giant has gone on the offensive. The Santa Clara (Calif.) chipmaker is slashing costs, has launched a no-holds-barred price war, and is diversifying into new markets. The goal: to use the downturn to grab share from weaker rivals while positioning itself for growth beyond the mature PC market when things turn up again.

MARKET MUSCLE. Still, it's a risky strategy--and one that's unlikely to do much for sales or earnings in the short term. Analysts expect Intel to post 2001 revenues as much as 20% below last year's record $33.7 billion, which would be its first annual sales decline in 15 years. And despite signs that the worst of the downturn may be over--the company said that sales may stabilize in the second half--analysts expect profits for the year to fall 58%, to $10.5 billion. "We are all kind of shell-shocked by the U.S. phenomena right now," sighs Intel Executive Vice-President Paul Otellini.

Things aren't much different for Intel's rivals. On Apr. 17, cellular chipmaker Texas Instruments Inc. (TXN ) also reported disappointing results, layoffs, and new cost-cutting measures. Indeed, big order cancellations and overcapacity will leave many chipmakers awash in inventory for months.

But Intel figures it can use its market muscle to reinvigorate its own PC sales. It and others are trying to goose the $81 billion PC chip segment, which accounts for about 40% of the semiconductor market, by slashing prices. Intel is even cutting prices for high-end products that carry the biggest premiums. A 1.5-gigahertz Pentium 4 chip, for instance, that sold for $637 three weeks ago has fallen 19% since to $519, and is down sharply from $795 in December.

The danger, of course, is a bloody battle that simply leaves margins tarnished. So far, Intel's major rival, Advanced Micro Devices Inc. (AMD ), is also slashing prices and gaining ground. On Apr. 18, it announced sales had jumped over the comparable year-ago period. Meanwhile, Texas Instruments, Motorola (MOT ), and others have focused on belt-tightening measures such as shorter work weeks.

To shore up its position in the core PC market, Intel is also moving ahead with a $7.5 billion capital spending plan that will let it switch to the latest chipmaking technologies. That could cut manufacturing costs by 30%, says CEO Craig Barrett. "You have to continue to invest or you don't come out stronger than when you went in," Barrett says.

Then there's Intel's plan to create a bevy of non-PC products. Those include chips for mobile phones, networking equipment, and consumer electronics. True, revenues from each of these lines represents less than 10% of Intel's annual total. But they have tripled since 1996 to $6.5 billion, and together make up 19.2% of 2000 fiscal year sales, Merrill Lynch & Co. estimates.

Admittedly, such new businesses won't provide a quick fix to Intel's current troubles. Nevertheless, investors want to believe the worst is over. Shares of Intel jumped 20% on Apr. 18 following the Federal Reserve's rate cut, five percentage points more than the typical chipmaker. But if sales don't pick up soon, that sucking sound could get much louder.

By Cliff Edwards in San Mateo, Calif., with Andy Reinhardt in Paris

— With assistance by Andy Reinhardt

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